You Could Have Avoided the Financial Crash

The viciousness, severity, and suddenness of the financial market's collapse last week caught many by surprise. Having a resource that provides some forewarning would be useful in our attempts to avoid stocks that will eventually flame out.

Fortunately, we do. And it's free. The investor intelligence community at Motley Fool CAPS has had a pretty good run so far at calling the downward spiral of some of the names you've been reading about all too frequently these days.

Every day, the 115,000 members of CAPS rate the ability of stocks to outperform or underperform the market, and a rating of one to five stars is assigned to the stock as a result, with five being the best. Each member is rated as well, with the opinions of the best, most consistent members counting more heavily in a stock's rating. Within each stock's CAPS page, you can check the trend over the past six months to see how your fellow investors are rating a company. And you don't have to pay a dime.

We don't recommend you use any of the ratings as strict buy and sell lists -- no service can be so prescient, and you always need to do your own research -- but according to CAPS data, the best five-star stocks outperform the market by 12 percentage points, and newly minted five-star stocks increase your odds of capturing those returns. In comparison, two-star stocks lost to the market by five percentage points, while the lowest one-star stocks lost 11% to the index.

You could have used this to your advantage to miss losing your shirt on any of the names that have imploded over the past week. For example, back in May of this year, American International Group (NYSE: AIG) dropped from a so-so three-star rating down to two stars. Back then, AIG was trading at around $40 a share; today the venerable insurer is a penny stock at $5 a stub.

Merrill Lynch (NYSE: MER) also had a change in fortunes back in May, when CAPS members downgraded the investment bank from two stars to the lowest one-star ranking. That could have saved you the misery of seeing your investment going from almost $50 to the $20s and the ignominy of having to run to Bank of America (NYSE: BAC) to save it. Yet, there were warning signs even further back in 2007. While the ratings trends only capture six months of ratings, it was referenced in an article in June of that year as being a three-star stock. By July, however, it suffered a crisis of confidence and dropped to a one-star stock in the estimation of investors even though it was still trading near $90 a share.

And Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) ? They were one-star stocks way before the government bailout.

Again, don't use the star ratings as buy or sell signals. Instead, use them as a launching pad for further research, and who knows? You just may help yourself avoid the next round of stocks to go down in flames.

Got an opinion on a stock? Bring it to Motley Fool CAPS where your opinion counts just as much as the professional traders'. And best of all, it's completely free!

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